Kohl's - Is The Dividend Safe?

| About: Kohl's Corporation (KSS)

Summary

Kohl’s has a strong national brand.

Growth will be challenged in the future.

Shareholder-friendly management continues to return cash to shareholders.

Kohl's (NYSE:KSS) is a department store that operates 1,150 stores across the United States. They sell moderately priced private label, exclusive and national brand apparel, footwear, accessories, beauty and home products. They generally carry a consistent merchandise assortment with some differences attributable to local preferences. Brick and mortar retailers have increasingly come under pressure from online sellers like Amazon (NASDAQ:AMZN). While I won't pretend to know what the future of retailing is, I will try to answer the question of what Kohl's financial stability looks like.

Kohl's is currently trading at ~$44.50 per share, which gives them a market cap of ~$8 billion (181 million shares). They also have $2.793 billion of long-term debt and setting this debt against the $700 million in cash they have on the books their enterprise value is ~$10 billion. This debt load is what worries me about Kohl's. With increasing competition from online retailers, a stagnating revenue stream and decreasing margins, I worry about what is going to happen to them especially since I am a personal fan of their moderately priced merchandise.

In the most recent quarter, they saw comp sales per store decrease by 1.8% and saw transactions per store down 4.8%. With these factors at play, I wanted to see what the dividend sustainability was for Kohl's and find out whether they would be able to continue to buy back shares. First, let's take a look at some of the key items from the income statement.

Kohl's

2007-01

2008-01

2009-01

2010-01

2011-01

2012-01

Revenues

15,597

16,474

16,389

17,178

18,391

18,804

Operating Income

1,815

1,804

1,536

1,859

2,092

2,158

Net Income

1,109

1,084

885

973

1,120

1,167

Shares

335

320

307

306

306

271

EPS

3.31

3.39

2.89

3.17

3.66

4.30

Dividends

0.00

0.00

0.00

0.00

0.00

1.00

Free Cash Flow

1,957

(307)

687

1,568

915

1,216

LT Debt

1,059

2,065

2,053

3,940

2,096

2,141

Click to enlarge

5 yr.

9 yr.

Kohl's

2013-01

2014-01

2015-01

2016-01

CAGR

CAGR

Revenues

19,279

19,031

19,023

19,204

1%

2%

Operating Income

1,890

1,742

1,689

1,553

-6%

-2%

Net Income

986

889

867

673

-10%

-5%

Shares

237

220

204

195

-9%

-6%

EPS

4.17

4.05

4.24

3.46

-1%

0%

Dividends

1.28

1.40

1.56

1.80

Free Cash Flow

480

1,241

1,342

784

-3%

-10%

LT Debt

2,492

2,792

2,780

2,792

6%

11%

Click to enlarge

· Chart compiled by author using data from Morningstar.com

From the chart above, we can see that revenue has risen at a 1% CAGR over the last 5 years, definitely nothing to write home about. We can also see that operating income has been negative over both the 5-year and 9-year time span and that net income has been even more negative than operating income, which shows us that margins have been under pressure.

Margins have been pressured by increasing wages, store closings and increased price competition from other retailers. We can also see that debt has grown at the same time operating & net income is falling. Generally, this is not a great thing for the long-term prospects of any organization unless the company has been using the debt for good purposes.

Kohl's does create quite a bit of free cash flow (FCF) which is the lifeblood of any company, generating an average of ~$1.1 billion per year over the last 3 years. This gives Kohl's a trailing 12-month FCF yield of around 11% based upon their enterprise value of $10 billion. They currently pay a generous dividend of $0.50 per share on a quarterly basis, which gives them a current dividend yield of ~4.5%.

This is 2.1 times the S&P 500 dividend yield of 2.10%. Based upon their 181 million shares outstanding as of 7/31/16, they will need cash flow of ~$362 million to pay their yearly dividend obligations. Since they are producing ~$1 billion of FCF annually, they should easily be able to continue to pay this dividend for the foreseeable future. But remember that debt load of $2.7 billion, how manageable is that?

30-Jul-16

Outstanding

Maturity

Effective

Coupon Rate

Outstanding

January 30, 2016

August 1, 2015

Rate

(Dollars in Millions)

2021

4.81

%

4.00

%

$

650

$

650

$

650

2023

3.25

%

3.25

%

350

350

350

2023

4.78

%

4.75

%

300

300

300

2025

4.25

%

4.25

%

650

650

650

2029

7.36

%

7.25

%

99

99

99

2033

6.05

%

6.00

%

166

166

166

2037

6.89

%

6.88

%

150

150

150

2045

5.57

%

5.55

%

450

450

450

2017

-

-

-

-

318

4.88

%

2,815

2,815

3,133

Unamortized debt discount

(5

)

(5

)

(5

)

Deferred financing costs

(17

)

(18

)

(19

)

Current portion of long-term debt

-

-

(318

)

Long-term debt

$

2,793

$

2,792

$

2,791

Click to enlarge

· Chart is from recent 10-Q filing dated 7/31/16

This chart of long-term debt taken from their recent 10-Q filing shows that Kohl's has $650 million coming due in 2021. Then they also have $650 million coming due in 2023 and 2025. So if Kohl's continues to bring in around $1 billion of free cash flow and continues to pay around $360 million of dividends annually, they will have plenty of cash available to pay the debt as it comes due in 2021, 2023 and 2025.

The question that looms large is obviously, what does FCF look like over the next 5 years? Also, what do they do with any extra cash they produce over the next few years? Will they use it to buy back shares, raise the dividend or save it to pay the upcoming debt. Or maybe they can continue to roll over the debt.

In the near term, Kohl's should have no problems paying their dividend and potentially using the extra cash they produce to either raise the dividend, buy back shares, open more stores, update stores or save it.

The biggest question that I unfortunately can't answer is what Kohl's looks like in the early 2020s as that is when rubber will hit the road. If Kohl's can figure out how to sustain their cash flow in a world where brick and mortar seems to be losing ground everyday or if they save their cash prudently for debt coming due in the future they should be just fine.

If they raise dividends too aggressively or use all their excessive cash flow to buy back shares, they may have an uh-oh moment in 2021. Only time will tell. At the present moment, I believe this discount retailer is making smart decisions to close underperforming stores, and in the most recent quarter, they did have 21% of their sales come from their online and in-store pick-up channels, but they must continue to make prudent decisions with their cash flow to continue to survive in today's cutthroat retailing environment.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.